What You Need to Know When Dealing with Distressed Transactions

distressed transactions

Many factors can cause a company to struggle, sending it into financial distress that eventually results in it having to sell assets. Ever-evolving industry conditions, constraints on liquidity, increasing amounts of debt, the loss of key leadership, as well as limited access to capital are a few challenges that create stumbling blocks that can lead to a distressed transaction.

Distressed transactions are the double-edged sword of the M&A world. An extremely stressful time for one organization can pose a potential opportunity for another. As the buyer in this equation, there are specific things you need to know when dealing with distressed transactions.

Negotiating Debt

When a company must initiate a sale under unfavorable conditions, it’s not a decision to be taken lightly. Often, attempts have been made to lessen their liabilities. The company may have sought waivers or amendments to debt securities or credit facilities. As a final measure, a sale of some or all of its assets provides an alternative to bankruptcy.

Because of this, it’s important for a potential buyer to understand that they aren’t simply negotiating a final agreement with the seller. They’re also negotiating terms with any lenders or lien holders who are still involved. This will make the process much more complex and time-consuming than a typical M&A transaction.

Determining Value

As a buyer in a distressed transaction, your first goal is to understand the real value of the assets being purchased. This can prove difficult in a distressed sale because the company and/or its assets are not being sold under typical market conditions.

Making matters more difficult, time is of the essence in a distressed transaction, as sellers typically need to close a deal and rid themselves of their assets a quickly as possible. Because of this, due diligence must be accurate, but it must also be executed in an efficient manner.

Once the value is determined, it should reflect the financial challenges the seller is currently facing. Because of this, distressed transactions pose an attractive opportunity for buyers to obtain assets at a significant discount and build a plan to put things on a track to profitability.

Understanding an Asset vs. Stock Purchase

Another key factor potential buyers should educate themselves about is the difference between an asset purchase and a stock purchase. In an asset sale, the buyer purchases all or some of a company’s assets. This allows the parties to specify which assets and liabilities will be part of the transaction, providing the buyer the opportunity to reduce the risk of acquiring a whole host of liabilities.

In a stock sale, the seller transfers stock or equity interests from the equity holders to the purchaser. In these types of transactions, the buyer purchases an ownership stake in the company. Sellers generally prefer this kind of distressed transaction, as it unburdens them of the company’s liabilities as well as its assets.

Buyer Beware with Distressed Transactions

As negotiations play out, the potential buyer should be cautious of signing any agreement without reading and fully understanding the terms first. Some agreements in distressed M&A transactions will feature confidentiality clauses that forbid the purchaser from discussing the sale with any third parties. These types of clauses are not acceptable, as a buyer should be free to discuss the transaction with all of the seller’s creditors in order to obtain a comprehensive perspective of the potential acquisition.

With such a large number of factors at play, it’s helpful to work with an M&A firm that is experienced in working with distressed transactions. MelCap Partners has the skill and expertise necessary to assist in every step of your acquisition, from finding the best candidates to negotiating a successful transaction.

By Al Melchiorre

Al founded MelCap Partners in 2000, and is responsible for managing all aspects of client engagements from proposal through closing, developing business, reviewing offering memorandums and financial models, negotiating purchase agreements, and interacting with buyers and investors.